Managing your money in retirement can be very difficult. There are three competing concerns:
- To generate enough income for expenses.
- To have the amount of money you possess grow over time so that you’ll be able to keep up with inflation.
- To make your money last for the rest of your life.
We’ll look at assets for doing each of these things in this series of posts and then talk about some overall strategies.
Generating income: The traditional way to generate income is to buy bonds and dividend paying stocks, or buy mutual funds that invest in these types of assets. Mutual funds that specialize in these types of assets would generally have “income” or “bond” in their name. Because utilities have traditionally paid large dividends, finding a mutual fund or ETF that specializes in utilities is also a possibility. Other good sources of income include Real Estate Investment Trusts (REITs), Master Limited Partnerships, and bank stocks.
A second way to generate income is to sell stocks periodically to turn them into cash. This has the effect of depleting the number of shares you own over time and can be dangerous if the market falls when you need to sell shares for income. Some years you will see big gains, while others you will see modest or even sharp losses. If you have a large enough portfolio such that you are not selling off a large percentage per year (no larger than 1-2%), market dips generally won’t be an issue since the portfolio will be able to replenish itself over time. If you need to sell a larger portion each year to meet expenses, however, you may not have time for the stock prices to recover before you’ve sold off too much and your portfolio starts the inevitable death spiral. This is where you’re selling of a greater percentage of the account each year, so it generates less income, so you need to sell even more until you’ve sold everything.
A final way to generate income is to buy an annuity, which is a product sold by insurance companies where you give them a lump sum of money and they pay you a specified income. Some annuities begin to pay you right away, called an immediate annuity. These types of assets can be useful because they can guarantee you an income just like a traditional pension, but often the fees are large and the returns substandard. Still, this may be the best choice if your retirement assets are limited and you otherwise stand a good chance of running out of money. You should definitely shop around and do a careful analysis of the rate of return you’ll be receiving compared to other choices such as a bond portfolio or bank CDs. Some individuals selling these products also know little about them and are mainly motivated by the commission they’ll receive.
There are also annuities that pay you after you reach a certain age, like age 85 say, called deferred annuities that can be useful to make sure you’ll have money if you live longer than you were expecting. These are really an insurance policy where you don’t really expect to collect anything close to what you paid in, if anything, but the peace of mind for knowing that you’ll have at least some income is worth the price. Again, do a careful analysis. If possible, go through a financial adviser who does not receive any sort of commission from the sale of the annuity, such as one that receives an hourly fee to advise you rather than a commission from product sales.
The general issue with buying only income assets is that the value of the income you’ll receive over time will decline. Note that the price of a Coke in a vending machine in 1990 was $0.50, where now it is $0.75 or even $1.00. If you bought a set of income assets back in 1990, you would still be receiving the same income you did back then, but the price of things is 50-100% more, so your income has effectively declined. You can stop this effect to a degree with some dividend paying stocks since then the amount paid in dividends each year may increase. There are various guides that list stocks that have increased their dividends each year for a long period of time, which is a good place to start.
In the next post I’ll talk about assets that allow you to keep up with and even surpass inflation.
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Disclaimer: This blog is not meant to give financial planning or tax advice. It gives general information on investment strategy, picking stocks, and generally managing money to build wealth. It is not a solicitation to buy or sell stocks or any security. Financial planning advice should be sought from a certified financial planner, which the author is not. Tax advice should be sought from a CPA. All investments involve risk and the reader as urged to consider risks carefully and seek the advice of experts if needed before investing.
